Stock Corrections After Long Winning Streaks

“If you have trouble imagining a 20% loss in the stock market, you shouldn’t be in stocks.” – John Bogle

Ryan Detrick shared an interesting chart on his blog this week:

He showed that going back to 1950 there have only been four bull market streaks that lasted longer than the current one without the S&P 500 experiencing a 10% correction. Many are saying we are overdue for a correction but the market doesn’t always cooperate with cliches. These things can last much longer than most people realize.

Some investors are sure we’re heading for a crash because we’ve had such an uninterrupted rise in stocks. While a crash is never out of the realm of possibilities, just because stocks are up doesn’t mean they have to immediately crash.

I shared Ryan’s chart on Twitter and was asked how large the subsequent losses were once the market did finally pullback following these rallies. Here’s what I found:

There were a couple of crashes after these lengthy rallies, but the majority of these were run-of-the-mill corrections that you should plan on experiencing every few years in the stock market.

It can be difficult to remember this fact after it seems like the market only goes up in the midst of a strong bull market. Periodic losses help weed out the real long-term investors from the bull market groupies. It’s an unfortunate byproduct of the zero sum nature of investing.

Plenty of pundits have been calling for a pullback for a while now. Eventually they will be right. It’s the timing that gets you on these type of calls.

Wow, seven years! And followed by only an 11 percent correction? That’s insane!

Honestly I’m not sure what to tell clients when they ask about whether we’re “due” for a correction. Obviously, as you’ve pointed out, these things can last a long time without the market behaving “rationally”.

So my answer is always, I don’t know, and that you should just stay focused on a long term strategy.

There is a key distinction between the stock market (i.e. trading) and the underlying companies that make up a stock market that I think you might be getting mixed up:

Stock market – Let’s take the entire U.S. stock market as an example (represented by the CRSP U.S. Total Market Index). Last year, the index delivered a total return of 33.6%. That was the weighted average return of every company within the index, regardless of who owned what at any time during the year. No matter how the market was traded, the end result was 33.6% (before fees and taxes of course). That is the very definition of a zero-sum game.

Companies – On the other hand, the companies themselves (as participants in a wealth-creating economy) are not playing a zero-sum game. Through innovation, they are able to reduce costs, deliver better products/services, and create things that never before existed. Consumers and businesses who trade money for products/services they place greater value on than the money they gave up are obviously better off. However, to bring it full circle, the companies created an aggregate amount of wealth that is not impacted (in any meaningful way) by how their shares were traded on the stock market.

In addition to knowing stats such as these, defining the “risk profile” of the market that is present, can be productive towards knowing if an impending market pullback/correction will be of lower risk to reward (towards allocating new assets towards equities) than at a later time.

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BEN CARLSON, CFA

A Wealth of Common Sense is a blog that focuses on wealth management, investments, financial markets and investor psychology. I manage portfolios for institutions and individuals at Ritholtz Wealth Management. More about me here.

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